The great minimum wage debate: how Obama's proposal to increase the minimum wage will impact the economy

In this Friday, Dec. 28,2012 photo, Kaylee Feight talks about the impact a minimum wage increase would have on her job at Quiznos in Helena, Mont. In his recent State of the Union address, President Obama called for increasing the minimum wage to $9 per hour, up from its current $7.25. Critics say it would increase unemployment.

Associated Press

Summary

In his recent State of the Union address, President Obama called for increasing the minimum wage to $9 per hour, up from its current $7.25. Critics say it would increase unemployment.

President Barack Obama's call for increasing the minimum wage during his State of the Union address last week has renewed debate among policy experts, politicians and economists, who argue that if enacted the proposal could either drive up unemployment or create more stability for America's poor.

Obama wants to increase the minimum wage from its current $7.25 to $9 an hour, which he said would reduce the number of people in America who work full time but who live in poverty. "This single step would raise the incomes of millions of working families," he said last week. "It could mean the difference between groceries or the food bank; rent or eviction; scraping by or finally getting ahead. For businesses across the country, it would mean customers with more money in their pockets."

Against the increase

Those who oppose a minimum wage increase typically do so on the grounds that it will cause unemployment. House Speaker John Boehner summed it up this way in his response to the president: “When you raise the price of employment, guess what happens? You get less of it. At a time when Americans are still asking the question ‘Where are the jobs?’ why would we want to make it harder for small employers to hire people?”

Michael Saltsman, research director for the conservative Employment Policies Institute in Washington, D.C., agrees. "Over 85 percent of [economic] studies in peer reviewed journals say job loss occurs after an increase in minimum wages,” he said. “Economists are not divided on this issue."

For large increases to the minimum wage, the impact is obvious, Saltsman said. Imagine how businesses would react if they had to pay every employee over $100,000 a year. But even small increases can hurt the bottom line of a business, particularly those in low profit margin industries, Saltsman said. Businesses in competitive markets react by passing costs on to customers or finding ways to make do with fewer employees. Saltsman uses the example of grocery stores that have responded to higher labor costs by installing self-checkout lanes.

The president’s motive for increasing the minimum wage is to improve the standard of living for working class Americans. According to Saltsman, increasing the minimum wages doesn’t deliver the goods. “Some people will be better off, but the losers outnumber the winners,” he said.

Saltsman believes the Earned Income Tax Credit (EITC) is a better way to help low-income Americans. Someone working full time at the current minimum wage of $7.25 an hour is eligible for a tax credit that bumps their wage to approximately $9.75 an hour, Saltsman said. The difference is that since the money doesn’t come directly from employers, businesses aren’t forced to cut jobs. Saltsman also suggests that the EITC could be improved by distributing benefits on a monthly basis instead of as a lump sum at the end of the year to make budgeting easier for low-income families.

In support of increases

Douglas Hall, director of the Economic Analysis and Research Network at the Economic Policy Institute, a liberal think tank based in Washington, D.C., argues that just because basic economic theory predicts that increasing the minimum wage will cause unemployment isn’t proof by itself. “Saying something a lot doesn’t make it true. Primitive economic theory does not explain the complexity of the modern economy,” he said.

A growing body of peer reviewed economic research suggests Hall might have a point: when it comes to assessing the impact of increasing the minimum wage, the standard economic assumptions don't always hold.

For example, Berkeley economist David Card and Alan Krueger, chairman of the White House Council of Economic Advisors, have shown that an 18 percent increase in the minimum wage in New Jersey did not decrease employment in the state’s fast food industry. On the contrary, they found that the number of fast food jobs went up after the change.